Mortgage Interest Tax Deductions You Can’t Afford to Miss

Mortgage Interest Tax Deductions

Mitchell Fox is a Tax Nerd and the Co-Founder of GoodApril, a site that provides consumers with online tax planning and tax advice services and offers a free “Tax Checkup” to help you identify actions you can take to reduce your taxes. You can follow Mitch on Twitter at @mitchellwfox or @goodapril.

Your home loan is the biggest debt you will probably pay off in your life.

If your mortgage is the 800 lb gorilla of your overall financial picture, you’re not alone. For many people, the purchase of a home is the largest financial commitment they’ll ever make. While the tax advantages of home ownership are often mentioned as a reason to own instead of rent, you may not know the specific benefits of paying down your mortgage.

Let’s start with the basics:

Mortgage Interest Deduction

The interest you pay on your mortgage is deductible from your taxes each year if you itemize your deductions rather than taking the standard deduction, which the majority of American homeowners do. (If you attach Schedule A to your tax return, you itemize)

What that means is that if $15,000 of your $30,000 in mortgage payments this year go to paying off interest on the loan, then you can claim that amount as a mortgage interest deduction. Keep in mind that a tax deduction simply reduces your taxable income – it is not the same as a credit, which reduces your total tax on a dollar-for-dollar basis. In our example, the mortgage interest deduction would reduce your taxable income by $15,000. At a typical tax rate of 28%, that will reduce your tax bill by about $4,200.

Interest is deductible on only the first $1 million of debt, so long as it is used for acquiring, constructing, or substantially improving a primary or secondary residence. You can claim the mortgage interest deduction on both your first and second homes if you’re lucky enough to have two.

If you have a rental home, you can also benefit from your mortgage payments on it, but under different rules related to Rental Income, part of Schedule E on your tax return.

Home Equity Interest

The interest on home equity loans used for “capital improvements” to a home can also be deductible from your income on your taxes. On loans of up to $100,000, the interest is tax-deductible for a homeowner who uses the loan to make improvements to the home such as adding square footage, upgrading the components of the home, or repairing damage from a natural disaster.

Consolidate Debts with Rise
Buying or Selling a Home in 2016?
Agent Ace uses historical home sale data to identify the #1 agent in your market to find your perfect home or sell your home for more. Get My Agent

Property Tax Benefit

While not directly related to paying down your debt, the property taxes you pay to the local or state government based on the value of your home are similarly deductible if you itemize. So, if you pay $3,000 in property taxes this year, you will see over $856 in actual tax savings.

Be careful, however: while many states and counties also impose property taxes for local improvements to property, such as assessments for streets, sidewalks, and sewer lines, these cannot be deducted.

But perhaps you’re no beginner, and these tax benefits are in fact part of why you decided to buy a home in the first place. What else should you be thinking about?

Private Mortgage Insurance (PMI)

If you are unable to make a down payment of 20%, mortgage lenders will often require a homebuyer get some sort of Private Mortgage Insurance. Depending on the size of the mortgage, PMI can be a few dollars to hundreds of dollars per month.

If your mortgage payments include PMI, it may qualify as a tax deduction. The deduction is available to homeowners with adjusted gross incomes below $100,000 and is phased out, 10% per $1,000, for taxpayers with an AGI between $100,000-$109,000.  Those limits are lower for taxpayers who are married but filing separately.

An Example

To help see how these various elements of paying off your home mortgage fit together, let’s look at a simplified example of a $600,000 California home purchased one year ago.

Home purchase price: $600,000
Down payment: $120,000 (20%)
Mortgage value: $480,000
Interest rate: 4%
Monthly payment: $2,625 – broken out by:

Principle repayment: $734
Interest: $1558
Property Taxes: $255
PMI: $78

Each of the interest, property tax, and PMI payments could be deductible from income on your taxes. The impact, for someone in the 28% tax bracket, would be:

Interest: $5,235 savings (based on $18,696 deduction)
Property Taxes: $857 (based on $3,060 deduction)
PMI: $262 (based on $262 deduction)

That’s pretty significant! Anyone who owns a home needs to be aware of these opportunities for mortgage interest tax deductions. So, while paying down your mortgage debt may be a significant and at times challenging undertaking, at least it’s one that offers tax advantages along the way.

Image credit: iriana88w

Receive updates:      
You can always unsubscribe by clicking on the link at the bottom of each e-mail.

  • If you save at least 20 percent for a deposit, you can put all that insurance money into purchasing the house itself.

  • Brian

    What if you have a $150K mortgage financed at the 4% rates we have today? When you consider the std deduction for a married couple filing jointly, is there REALLY any tax savings? I’ve itemized for 10yrs and every time, my deductions never exceed the standard deduction, so how does owning a relatively low-priced home, with a low interest rate, and low property taxes actually “help” me? (and I know some people will say that I’ll have a home paid for in retirement, and that’s a valid point, but until then….)

    • That’s interesting, Brian, thanks for your comment. So it sounds like you’re saying that in your case the mortgage interest deduction doesn’t have any benefit since it never exceeds the standard deduction, right? That’s probably good for people to know – especially if their situation is going to be similar to yours.